There once was a large bloc of nations
That gathered to foster relations
On how they should trade
That they might dissuade
A conflict midst trade accusations
But slowly their mission expanded
As rules on more things they demanded
One nation resented
Requests which they thought heavy-handed
This nation expressed their dissention
By voting to leave that convention
But three years have passed
And no deal’s amassed
Support so they need an extension
I apologize for the length of this morning’s ditty, but sometimes it takes more than one stanza to tell the story.
Brexit is once again the top story today, although the FOMC meeting and US-China trade talks are still in the news. With just nine days left before the UK is due to leave the EU, there is still no agreed upon deal between the two sides of the negotiation. Today, the EU has a council meeting of all its leaders and PM May will be making a speech and asking for an extension. The question has been, how long would she request? At this time, it appears it will be short, just three months, as she is seeking to get the negotiated text voted on in Parliament one more time. However, there has been pushback by several other EU members concerned that three months won’t be enough time to change anything. In fact, some EU members want a much longer delay in order to push for a second Brexit vote; you know, to get the ‘right’ answer this time. At any rate, Brexit continues to be a slow-motion train wreck and all are fascinated to watch, if not to live through its consequences.
As an aside, a conversation I had yesterday with a local who has become more engaged in politics there, indicated that there is an abject fear of leaving without a deal, and that despite the many bad things about PM May’s deal, there will be many MP’s who vote for it rather than allowing a hard Brexit. Certainly that is what May is counting on. We shall see. The FX market continues to react to the ebbs and flows of the conversation and this morning is ebbing. The pound is down 0.3% as it seems some traders are losing confidence in the outcome. As I have repeatedly said, despite the fears of a no-deal outcome, the law remains for the UK to leave next Friday whether there is a deal in place or not, and that is a non-zero probability. If that is the case, the pound will suffer greatly, especially because that is clearly not the current expectation. Hedgers be ready.
On to the FOMC, which will release their policy statement at 2:00 this afternoon, along with their latest economic projections (expected to see GDP growth lowered slightly) and the infamous dot plot. Chairman Powell had made an effort, prior to the quiet period, to minimize the importance of the dots as those projections do not contain error bars showing the level of uncertainty attached to the forecasts. But the market is still talking about them non-stop. I guess six years of harping on the importance of forward guidance, BY THE FED, has trained market participants to pay attention to forward guidance. My money remains on the idea that the median dot will be at no more rate increases this year, and a more pronounced reduction in the long-term neutral rate. However, there are a number of analysts who are warning that the dot plot could look much more hawkish, highlighting another rate hike this year and one more next year. if that is the case, I expect equity markets to suffer, as it is pretty clear the market has priced out any further rate hikes.
In addition, we cannot forget the balance sheet story, where I remain convinced that the balance sheet roll-off will be slated to end by June, and that the composition will be focused on shorter term securities. The idea that shortening the maturity profile now will result in more ammunition for fighting the next economic downturn will prove quite appealing. After all, a big fear of the Fed is the howls of protest from the Austrian school (read Congressional monetary hawks) if they restart QE during the next recession. Shortening the average maturity of holdings now will allow them to maintain the size of the balance sheet while still adding stimulus in the next downturn by extending the maturity then.
And finally, on the trade front, despite a story yesterday indicating the Chinese were backing away from earlier agreements on IP security, the US delegation of Lighthizer and Mnuchin are heading to Beijing this week, with the Chinese delegation expected to come back here the week after in the final push for a deal. Certainly, equity markets have priced in a successful deal here, and probably so has the dollar. Interestingly, Treasury markets continue to look at the world with a very different view of much slower growth now, and in the future. It appears there is a bit more skepticism by bond traders on the successful outcome of a trade deal, than that of equity traders.
Overall, the dollar is marginally firmer this morning, but as we have seen the last several days, individual currency movements have been muted. The Indian rupee continues to perform well as an equity market rally in Mumbai has drawn in foreign investment and the market increasingly prices in a Modi victory in the upcoming election, which is seen as the most economic friendly outcome available. But even there, the rupee has only rallied 0.3% this morning. Throughout the G10, movement continues to be extremely limited, with 0.1% being the extent of today’s activity (the pound excepted).
Ahead of the FOMC meeting, there is no data to be released today, and equity futures are basically flat, pointing to very modest 0.1% declines on the open. Look for very little movement until the FOMC announcement and the following press conference. And then, it will all depend on the outcome.